This is the economic theory based on the use of capital for production purposes. It has three basic components:

A free market which generates prices

Manufacturing freedom for producers which can use those prices to perform economic calculations thus maximizing the productive capacity of savings

Private ownership of the means of production

Capital versus Income

Because capitalism operates on prices, which is to say money, it is possible to differentiate and classify the origins and purposes of money. This is an arbitrary classification but a very important one nevertheless. The difference is between the goods to be consumed now and the goods to be consumed in the future, quantified in terms of money.

Capital is money that will be used now (or preserved) in such a manner as to (hopefully) increase the capacity to consume in the future.

Income is the money available now for consumption that is not capital.

By knowing the difference between capital and income this allows people to live within their means.

In other words, examples of Capital are:

Saved money

Accumulated capital goods (e.g. house)

Accumulated production goods (e.g. a shoe making company)

Examples of Income are:

Wages

Return on investments (such as dividends or interest payments)

Profit from manufactured goods or services

The main idea or goal is to have sufficient wealth to live day-to-day while accumulating capital so that this capital produces increasing amounts of profits over time; profits that will be consumed in the future (e.g. retirement).

Strictly speaking, the goals of economic calculations in a capitalist system are to enable the quantification of:

Income

Savings

Capital consumption

Capital consumption is simply the amount of capital that is used for consumption purposes, for example upon retirement. Capitalism is the only economic theory that allows for these calculations.

Economic calculations

We have previously explained why Praxeology does not make use of empirical calculations to determine theoretical issues. Praxeology is a logical science, not an empirical one. However, ironically enough, until Capitalism (or pure free markets) emerged allowing for economic calculations, Praxeology did not emerge.

This was so because until there was money it was not possible to determine if there were theoretical problems with economic actions based on calculations. We must remember that although Praxeology does not utilize calculations for theoretical purposes, people use economic calculations all the time to determine their actions.

Furthermore, we must never forget that as the wealth of money is subjective, these "economic calculations" are simply individual estimates carrying no objective weight whatsoever.

When money first emerged in ancient times, people began to study the logic behind exchanges of goods and services because this logic could now be quantified using money. The logic of exchanges was no longer pure assumption but it could be investigated using economic calculations. This is how economic theories in general and Praxeology in particular originated. And again, we must remind our readers that economic calculations are perfectly valid tools to investigate economic issues but they are invalid tools as theoretical proofs.

Eventually and with the aid of economic calculations economists unveiled a complete system based on the logic of economic exchanges. However, once they have done so, they realized that this logic can be extended to any human action, thus Praxeology was born.

The tyranny of capitalists

So far we have learned that a free market produces prices. These prices convey information to producers (capitalists) who use this information in order to spend savings buying production goods or services in such a manner as to manufacture a product which will yield the maximum possible profit.

In other words, thanks to free pricing in free markets producers can maximize profits.

Seen under this light it is possible to conclude that producers maximize profits to the expense of consumers. Furthermore, it is possible to conclude that as producers produce goods and services and those goods and services are under their absolute control, they exercise absolute control over consumers. Consumers have no choice but to purchase whatever producers produce at the prices producers set. In other words:

We, the consumers are at the mercy of the tyranny of capitalists.

It is true. Seen under this light it is possible to so conclude, and it would be ridiculously erroneous to do so because these conclusions are based on the idea of a unidirectional free market. This is, this conclusion is based on the notion that consumers have no choice but to buy the offered products and services at the offered prices.

But there is no such thing as a unidirectional free market. At the very core of a free market rests the notion of voluntary agreements. Although it is true that producers can produce whatever they want and set whichever prices they want, it is also true that consumers can withhold their money from whichever producer they want.

The information conveyed by prices in a free market helps determine producers how to spend savings in production goods so that customers voluntarily purchase manufactured consumer goods or services at a price they are willing to pay for.

In other words, thanks to free pricing in free markets producers can manufacture goods and services people want at a price they can afford thus maximizing their profits.

Profit maximization happen only if:

The desirable good or service is offered for sale

At a price people are willing to pay for

There is no such a thing as a capitalist tyranny because free markets are two way streets. Capitalists and consumers are interdependent. One cannot be successful without the other.

The tyranny of consumers

We can reverse the same arguments and state that those poor, poor producers are at the whim of those tyrannical consumers. Yet, strangely enough, this is not an argument that we see very often. As a matter of fact, this argument is almost never used. The etiology (origin) of this argument is outside this lesson's topic but it suffices to say that voters who do not need rescuing do not vote for rescuers. The truth is that such statements are equally in error as the ones we developed claiming that there is a capitalist tyranny.

In reality and reversing our definition for markets, we can state:

Thanks to free pricing in free markets consumers can choose the goods or services they want thus maximizing their savings and satisfaction.

We can do so precisely because true free markets are symmetrical and as such there are no winners and losers but only winners and winners.

Control mechanisms

This is all theoretically wonderful, but what kind of control mechanism do we have in real free markets preventing a capitalist tyranny? There are three possible scenarios.

The first scenario implies a producer with a natural monopoly. This producer has a good or service that no other producer has. As such one would suppose that this producer would be able to set any price they so desire. But nothing could be further from the truth because at some price point, people would simply abstain from buying the product. Take for example a Rolls Royce. Its prices are exorbitant and very few people can afford them. But this does not bother you or us because we are not buying Rolls Royces. The Rolls Royce can set any price they want to their cars, but we simply abstain from buying them. Thus, if they want to sell cars, they will need to lower the price to a point at which sufficient people can buy them. In other words, even natural monopolies are always in competition for our money with completely different goods and services.

The second scenario implies a producer with direct competition. This producer has a good or service for which copies or similar products from other producers also exist. It is obvious that if the first producer raises prices, customers will simply buy from a competitor at a lower price. Thus, there is an upper limit to the price a producer can offer for a good or service.

The third scenario implies a producer manufacturing goods or services people do not want. Thus, people will simply abstain from purchasing those goods and services and the company will go bankrupt. So much for this company being tyrannical!

This is so because in a free market everybody is sovereign with their property and as such producers can either raise prices exorbitantly or even remove products from markets. But at the same time, consumers can withhold their money choosing not to spend it. The free market won't prevent either option but it will communicate through pricing the consequences of so doing.

In a free market every purchase or lack of thereof is a vote for a product or against it and as such for or against a given producer. It has been said that you can always vote with your feet but it is almost never stated that you can vote far more efficiently with your wallet.

Why efficiently? Because every purchase increases profits and every abstention decreases them. Every single purchase or abstention matters. This is in stark contrast with a democratic system where only the voters who elected the majority will see their preferences honoured. The minority will see them wasted.

It is true that in a free market people with higher wealth and thus higher purchase capacity have higher influence (or higher voting rights). However, they have achieved this enviable position only through the process of satisfying other people's needs with an efficiency superior to their competitors. In other words, their higher voting capacity was given to them by the votes of their customers. They earned this higher voting capacity by serving people better than their competitors. Furthermore, if they want to continue enjoying this privilege they must continue receiving the votes of their customers, this is, they must continue satisfying their customer's needs far better than the competition.

It is for this very reason that it is not possible to remove "rich" people from the market and expect it to maintain its efficiency. If we do so, we are removing the people that are the best at satisfying our needs! Rich people are tied to us through the market. If we want the best goods and services to satisfy our needs, then we need the best people to do so. As these people are also selfish, they will require suitable incentives to do so and this means larger profits. The point is simple:

If you want maximum market efficiency to satisfy your needs, then you need to accept the existence of rich people.

Classes and actions

Most political and economic theories typically relish themselves in showing how consumers are "exploited" by producers. They hypothesise and standardize and define and poll and finally calculate "damming" statistics so showing. This is, of course, all very much interesting but it is also very much useless. The reason for being so is that there is no "pure" producer or a "pure" consumer. For one reason or another or at one time or another we are all producers and we are all consumers.

We are all consumers and producers.

We are all capitalists and workers.

We are all buyers and sellers.

A free market cannot exist should one of those roles disappear. Consider the following examples.

Anyone who spends money in life's necessities is a consumer. Anyone who works to make a living is a producer. Problem being, we all need necessities and we all need to work to make a living. In other words, a producer is also a consumer.

Anyone who saves more than what they consume is a capitalist. Anyone who earns wealth through work so that they never run out of wealth is a worker. The problem being workers save in addition to earn income and capitalists spend other people's capital beyond their means (i.e. loans) in order to earn future income. In other words, a capitalist is also a worker.

Anybody buying is a buyer. Anybody selling is a seller. But we all buy things and we all sell things (consumers and producers). In other words, we are all buyers and sellers.

The conclusion is obvious. There is no such a thing as a "class" of workers or a "class" of consumers. We are both.

In Praxeological terms we say that consumers and producers, capitalists and workers, buyers and sellers are simply roles or categories of actions. They simply label what people are doing at one point or another and to one degree or another, not how people are defined and most certainly not who they are.

Note: please see the Glossary if you are unfamiliar with certain words.